When creating Spousal Lifetime Access Trusts (SLATs), many individuals aim to take advantage of valuable estate and gift tax benefits while ensuring that their spouse has access to trust assets during their lifetime. However, a common concern is whether the structure of two SLATs—one created by each spouse for the other—could trigger the IRS’s “reciprocal trust” doctrine, which may negate those tax benefits.
What Is a Reciprocal Trust?
A reciprocal trust occurs when two individuals, typically spouses, establish trusts for each other that are too similar in their terms, provisions, and structure. Essentially, the IRS may view these trusts as a way for the couple to shift assets back and forth between themselves in a way that ultimately retains control or access. In such cases, the IRS could disregard the individual trusts and treat them as a single trust, which may lead to a loss of the tax benefits associated with the trusts.
The key issue with reciprocal trusts is that the IRS does not want individuals to create trusts simply as a method of shifting assets back and forth between each other to avoid taxes. If the trusts are essentially mirrors of each other, this could be considered a “tax avoidance” scheme.
How Can You Avoid Reciprocal Trusts?
To avoid the risk of your SLAT being classified as a reciprocal trust, it’s essential to ensure that the trusts have “meaningful differences.” Here are the primary factors to consider when structuring two SLATs:
- Different Beneficiaries
One of the most important factors the IRS considers is the list of beneficiaries. If both trusts have the same beneficiaries (e.g., each spouse as the sole beneficiary) the IRS may view them as reciprocal. To avoid this, it’s helpful to include different beneficiaries in each trust. For example, a trust might include children, grandchildren, or charitable organizations as beneficiaries in addition to the spouse. This creates a meaningful distinction between the two trusts, demonstrating that the trusts are not simply a means of benefiting each spouse in a reciprocal manner.
- Distinct Trust Provisions
Another way to avoid reciprocal trust classification is to structure each trust with different provisions. For example, one spouse’s trust might give the trustee discretion to distribute income to the children, while the other spouse’s trust could have restrictions or different distribution instructions. Even small differences in how each trust operates can help establish that the trusts serve distinct purposes and are not merely mirrors of one another.
- Different Trustees or Advisory Boards
The appointment of different trustees or advisory boards in each trust can help distinguish them. If both trusts are controlled or managed by the same individuals, the IRS may consider the trusts reciprocal. Having independent trustees or different advisory roles ensures that the trusts are treated as separate entities, which reduces the potential for the IRS to combine them.
- Distinct Powers of Appointment
Power of appointment refers to the ability of a person to decide who will benefit from the trust’s assets upon their death. If one trust gives the spouse a broad power of appointment (e.g., the ability to change beneficiaries), and the other trust does not, this can demonstrate that the trusts are distinct. Ensuring that each trust has unique powers of appointment or other forms of control is an important step in showing that the trusts serve different purposes.
- Different Assets or Contributions
Another way to create meaningful differences is by funding each trust with different assets. If each spouse contributes distinct assets to the trusts—such as real estate, stocks, or family business interests—this reduces the risk that the IRS will view the trusts as reciprocal. It helps show that each trust has a separate and distinct purpose beyond just benefiting the other spouse.
- No “Back-and-Forth” Benefit
The trusts should not be designed in such a way that they effectively allow for a back-and-forth of assets between the spouses. If each spouse is essentially passing assets to the other through their respective SLAT, the IRS may view this as an attempt to retain control over those assets. The trust should instead be structured to benefit both spouses while also benefiting other family members or charitable causes, preventing it from being a simple exchange of assets.
- Intended Control and Flexibility
The IRS is also concerned with control. If the trusts are set up in such a way that one spouse retains significant control over the assets in the other spouse’s trust (such as the ability to revoke, amend, or access the funds), the IRS may decide that the trusts should not be treated as separate for tax purposes. The more independent the trusts are, the less likely they are to be considered reciprocal.
Conclusion
When setting up SLATs for estate planning, it’s crucial to avoid creating reciprocal trusts by ensuring that each trust has meaningful differences. This involves creating distinct beneficiaries, provisions, and powers within each trust. By doing so, you can help ensure that the trusts retain their intended tax advantages while also achieving your estate planning goals.